Has The Russian Central Bank Thrown In The Towel?

The Central Bank of Russia (CBR) seems to have decided that it can’t beat the markets. On Wednesday November 5th, it announced an end to unlimited currency support interventions. It said it would spend a maximum $350m per day smoothing out fluctuations as the ruble approached the edge of a trading band. Once that limit was reached, the ruble would be allowed to fall out of the band. The final sentence of the CBR’s press release spells it out:

As a result of the implementation of this decision, the ruble exchange rate will be determined predominantly by the market factors.

Game, set and match to the markets, apparently.

But wait. This game is by no means over. In my previous post, I said that the way for the central bank to remain in the game was to play it aggressively. Defensive strategies do not work when there are finite resources, since they simply attract speculative attacks. The CBR understands this:

…the abandonment of unlimited foreign exchange interventions in the borders of the operational band will hamper prerequisites for speculative strategies against the ruble.

There is much less profit to be made from speculative attacks when the target refuses to defend against them. It’s a form of passive resistance, if you like.

Allowing the ruble to fall freely is an aggressive strategy on the part of the Russian central bank. And it is having the desired effect. Since the CBR’s announcement, the ruble has been in free fall, dropping by 11% in a week – and market players are panicking. Reuters reports that there are desperate calls for the central bank to intervene:

"This is full-blown panic, with signs of a self-fulfilling currency crisis," Dmitry Polevoy, chief Russia economist at ING Bank in Moscow, said in a note. "At such times, the central bank should intervene, after all if this isn't a risk to financial stability, then what is?"

The Russian official news agency ITAR-TASS reports that Russian households are converting rubles to other currencies:

Russia’s two largest retail banks
Sberbank and VTB-24 admitted households’ increased demand for foreign currency over the past week. Specifically, VTB-24 said the demand had soared by 3-4 times, adding it had set aside foreign currency cash reserves in advance.

This is a bad sign. Increased domestic FX conversions are a serious risk factor for financial stability, since domestic banks can be bankrupted by excessive demand for FX liquidity. They are also a risk factor for hyperinflation.

But the CBR foresaw this:

At the same time, in case of financial stability threats, the Bank of Russia will be ready to carry out additional interventions in the domestic foreign exchange market.

The CBR has no intention of allowing the ruble’s fall to cause a financial crisis. It will provide support on an ad hoc basis to calm panic and ease distress in domestic markets. Indeed it already seems to be doing so:

Chart from Tomas Hirst at Business Insider UK

So the CBR has certainly not thrown in the towel. It has simply changed its game strategy. Now, far from attacking it, market players – both international and domestic – are looking to it for support. Game, set and match to the CBR.

Mind you, the CBR could still be defeated by the combination of falling oil prices and rising inflation. The possibility of domestic economic collapse is real, and there is little the CBR can do about it: if it raises rates to choke off inflation it weakens the economy further, but if it cuts rates to stimulate growth it risks an inflationary spiral. As in all countries, the fate of the domestic economy ultimately rests in the hands of politicians, not the central bank.

UPDATE: It's not "game, set and match" to the CBR just yet. The ruble is falling again. It's "game on".